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Questions and Answers
What does the PEG ratio indicate?
What does the PEG ratio indicate?
Which factor is NOT considered when calculating the PEG ratio?
Which factor is NOT considered when calculating the PEG ratio?
What is essential for the growth rate used in PEG calculations?
What is essential for the growth rate used in PEG calculations?
Which type of EPS is NOT commonly included in the definitions of EPS?
Which type of EPS is NOT commonly included in the definitions of EPS?
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What does the PE ratio fail to account for?
What does the PE ratio fail to account for?
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What is the primary basis for determining the value of an asset in relative valuation?
What is the primary basis for determining the value of an asset in relative valuation?
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What type of assets is needed for effective relative valuation?
What type of assets is needed for effective relative valuation?
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When does relative valuation work best?
When does relative valuation work best?
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What should be used to standardize the price of assets during relative valuation?
What should be used to standardize the price of assets during relative valuation?
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What characteristic is associated with investors who benefit most from relative valuation?
What characteristic is associated with investors who benefit most from relative valuation?
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What is a potential advantage of using relative valuation?
What is a potential advantage of using relative valuation?
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Why might pricing errors in similar assets be easier to spot?
Why might pricing errors in similar assets be easier to spot?
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What does relative valuation suggest about the intrinsic value of an asset?
What does relative valuation suggest about the intrinsic value of an asset?
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What approach involves comparing a company to similar companies for valuation?
What approach involves comparing a company to similar companies for valuation?
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Which of the following is NOT used in the calculation of valuation multiples?
Which of the following is NOT used in the calculation of valuation multiples?
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If the average EV/EBITDA multiple for a sector is 16.5x, what would be the Enterprise Value for a company generating $5M in EBITDA?
If the average EV/EBITDA multiple for a sector is 16.5x, what would be the Enterprise Value for a company generating $5M in EBITDA?
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What is the denominator in a P/EBITDA multiple?
What is the denominator in a P/EBITDA multiple?
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Why is presenting findings on a relative valuation basis beneficial?
Why is presenting findings on a relative valuation basis beneficial?
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What market measure would you not find in the numerator of valuation multiples?
What market measure would you not find in the numerator of valuation multiples?
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What specific industry multiple is used for valuing cable TV companies?
What specific industry multiple is used for valuing cable TV companies?
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Which of the following describes the essence of relative valuation?
Which of the following describes the essence of relative valuation?
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Which financial measure is commonly associated with the retail industry for valuation?
Which financial measure is commonly associated with the retail industry for valuation?
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What is the primary function of valuation multiples?
What is the primary function of valuation multiples?
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What valuation method is Company A planning to use given their situation?
What valuation method is Company A planning to use given their situation?
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Which ratio is used to relate market price to earnings in Company A's valuation analysis?
Which ratio is used to relate market price to earnings in Company A's valuation analysis?
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Based on the information provided, which PE ratio belongs to Company C?
Based on the information provided, which PE ratio belongs to Company C?
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What is the formula for calculating the PE ratio?
What is the formula for calculating the PE ratio?
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What is the approximate net income of Company A for 2018?
What is the approximate net income of Company A for 2018?
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Which of the following describes the limitation mentioned about finding comparable firms?
Which of the following describes the limitation mentioned about finding comparable firms?
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What key factor can vary when computing the PE ratio?
What key factor can vary when computing the PE ratio?
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What is Company A's cash balance as provided in the data?
What is Company A's cash balance as provided in the data?
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What is the first step in understanding multiples according to the four steps framework?
What is the first step in understanding multiples according to the four steps framework?
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Why is knowing the cross-sectional distribution of a multiple important?
Why is knowing the cross-sectional distribution of a multiple important?
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In Proposition 1, what should both the value and the standardizing variable refer to?
In Proposition 1, what should both the value and the standardizing variable refer to?
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Which of the following actions is critical in the step of analyzing the multiple?
Which of the following actions is critical in the step of analyzing the multiple?
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When applying a multiple, what is a significant challenge faced in practice?
When applying a multiple, what is a significant challenge faced in practice?
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How is the value of a company with a certain EBITDA commonly estimated?
How is the value of a company with a certain EBITDA commonly estimated?
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What must one understand about the variable relationships when analyzing a multiple?
What must one understand about the variable relationships when analyzing a multiple?
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Which of the following is NOT a step in the four-step understanding of multiples?
Which of the following is NOT a step in the four-step understanding of multiples?
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Study Notes
Relative Valuation
- Definition: Estimating an asset's value by comparing it to similar assets in the market.
- Philosophical Basis: Intrinsic value is often impossible to determine, market price is based on characteristics and willing buyers.
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Information Needed:
- An identical or comparable asset.
- A standardized measure of value (e.g., dividing price by earnings).
- Variables to control for differences if assets aren't perfectly comparable.
- Market Inefficiency: Pricing errors are easier to spot and exploit when comparing similar assets.
When Relative Valuation Works Best
- When there are many comparable assets, and they are priced in a market.
- When a standardized measure of value can be used for comparison.
- Best for investors with:
- Short time horizons.
- Relative performance benchmarks.
- The ability to act on mispricings (e.g., hedge funds).
Multiples
- Measures that allow for quick estimation of a company's value.
- They compare a company to similar companies (e.g., using P/EBITDA multiples).
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Structure:
- Numerator: Market measure (Enterprise Value, Share Price).
- Denominator: Operational measure (EBITDA, Sales, etc.).
- Important: Not to be confused with financial ratios like Debt/Equity.
Most-Known Multiples
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Enterprise Value (EV):
- EV/EBIT
- EV/EBITDA
- EV/Sales
- EV/Gross Profits
- EV/Total Assets
- EV/Net Fixed Assets
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Market Capitalization:
- Market Cap/Net Income
- Market Cap/Dividends
- Market Cap/Net Cash Flow
- Market Cap/EBT (Earnings Before Taxes)
- Market Cap/Assets less Liabilities
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Stock Price:
- P/EPS
- P/Dividends per share
- P/Cash Flow per share
- P/Book Value per share
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Industry-Specific Multiples:
- Cable TV: MVIC/subscribers
- Retailers: MVIC/Square foot
- Technology: MVIC/patents
Market Approach and Industry Multiples
-
Example: EV/EBITDA and EV/Revenues Multiples
- Manufacturing, Retail, Consumption, Technology, Biotechnology, Social Networks all have different EV/EBITDA and EV/Revenues multiples.
The Four Steps to Understanding Multiples
- Define the Multiple: Ensure consistency in how the multiple is defined across users.
- Describe the Multiple: Understand the distribution of the multiple across comparable companies.
- Analyze the Multiple: Understand the relationship between the multiple and the key fundamentals.
- Apply the Multiple: Careful selection of comparable companies and accounting for differences.
Definitional Tests
- Proposition 1: The numerator and denominator should be based on the same claimholders within the firm.
- Proposition 5: Finding an identical firm is impossible, focus on accounting for differences in fundamentals.
- Greenwood & White (2006): Emphasize the importance of understanding the context and limitations of multiples.
Price Earnings Ratio (PE)
- Definition: PE = Share price / Earnings per share or Market cap / Net income available for common stockholders.
- Variations: It's important to consider whether the PE is based on current, trailing, or forward earnings.
- Important: Consider primary, diluted, or partially diluted earnings, accounting for extraordinary items, and accounting rules used (e.g., options expensing).
PEG Ratio
- Definition: PEG = PE / Expected Growth Rate in Earnings
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Definitional Tests:
- Make sure growth rate is on the same base, period, and from the same source.
- Use an earnings metric that corresponds to the growth rate estimate.
- Avoid Double Counting: Don't use forward EPS in the PE calculation if the growth rate is based on the current year.
Example: Company A Valuation
- Objective: Use the fastest method to value a private company based on public company information.
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Data:
- Public company data: PE, EVS, PBV ratios.
- Company A data: Net Income, Sales, Book Value of Equity, Debt, Cash.
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Focus:
- Using multiples to quickly estimate the value of Company A given the public company data.
- Need to choose the relevant multiple based on available data and the company's characteristics.
Different PE Ratios, Key points
- PE can be calculated using current, trailing, or forward earnings, each reflecting different expectations about company income.
- Understanding the different PE variants is crucial in comparing your valuation with other analyses.
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Description
Explore the principles of relative valuation, a method for estimating an asset's value based on comparable assets in the market. This quiz focuses on key concepts such as intrinsic value, market inefficiencies, and the effective use of multiples for valuation. Test your understanding of when and how to apply this valuation technique in the investment landscape.
